Transcript
Copyright © 2006, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Topic Five (5)
Budgeting and Profit Planning
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The Basic Framework of Budgeting
A budget is a detailed quantitative plan for acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called budgeting.
2. The use of budgets to control an organization’s activity is known as budgetary control.
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Advantages of Budgeting
Advantages
Define goalDefine goaland objectivesand objectives
Uncover potentialUncover potentialbottlenecksbottlenecks
CoordinateCoordinateactivitiesactivities
CommunicateCommunicateplansplans
Think about andThink about andplan for the futureplan for the future
Means of allocatingMeans of allocatingresourcesresources
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Choosing the Budget Period
Operating BudgetOperating Budget
2003 2004 2005 2006
The annual operating budget The annual operating budget may be divided into quarterlymay be divided into quarterly
or monthly budgets.or monthly budgets.
The annual operating budget The annual operating budget may be divided into quarterlymay be divided into quarterly
or monthly budgets.or monthly budgets.
A continuous budget is a 12-A continuous budget is a 12-month budget that rolls forwardmonth budget that rolls forwardone month (or quarter) as theone month (or quarter) as thecurrent month (or quarter) iscurrent month (or quarter) is
completed.completed.
A continuous budget is a 12-A continuous budget is a 12-month budget that rolls forwardmonth budget that rolls forwardone month (or quarter) as theone month (or quarter) as thecurrent month (or quarter) iscurrent month (or quarter) is
completed.completed.
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Self-Imposed Budget
A budget is prepared with the full cooperation andA budget is prepared with the full cooperation andparticipation of managers at all levels. A participativeparticipation of managers at all levels. A participative
budget is also known as a budget is also known as a self-imposed budgetself-imposed budget..
S u p erviso r S u p erviso r
M id d leM an ag em en t
S u p erviso r S u p erviso r
M id d leM an ag em en t
Top M an ag em en t
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Advantages of Self-Imposed Budgets
1.1. Individuals at all levels of the organization are viewed Individuals at all levels of the organization are viewed as members of the team whose judgments are valued as members of the team whose judgments are valued by top management.by top management.
2.2. Budget estimates prepared by front-line managers are Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top often more accurate than estimates prepared by top managers.managers.
3.3. Motivation is generally higher when individuals Motivation is generally higher when individuals participate in setting their own goals than when the participate in setting their own goals than when the goals are imposed from above.goals are imposed from above.
4.4. A manager who is not able to meet a budget imposed A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.imposed budgets eliminate this excuse.
1.1. Individuals at all levels of the organization are viewed Individuals at all levels of the organization are viewed as members of the team whose judgments are valued as members of the team whose judgments are valued by top management.by top management.
2.2. Budget estimates prepared by front-line managers are Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top often more accurate than estimates prepared by top managers.managers.
3.3. Motivation is generally higher when individuals Motivation is generally higher when individuals participate in setting their own goals than when the participate in setting their own goals than when the goals are imposed from above.goals are imposed from above.
4.4. A manager who is not able to meet a budget imposed A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.imposed budgets eliminate this excuse.
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Self-Imposed Budgets
Most companies do not rely exclusively upon Most companies do not rely exclusively upon self-imposed budget in the sense that top self-imposed budget in the sense that top
managers usually initiate the budget process managers usually initiate the budget process by issuing broad guidelines in terms of overall by issuing broad guidelines in terms of overall
profits or sales.profits or sales.
Most companies do not rely exclusively upon Most companies do not rely exclusively upon self-imposed budget in the sense that top self-imposed budget in the sense that top
managers usually initiate the budget process managers usually initiate the budget process by issuing broad guidelines in terms of overall by issuing broad guidelines in terms of overall
profits or sales.profits or sales.
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Human Factors in Budgeting
The success of budgeting depends upon three The success of budgeting depends upon three important factors:important factors:
1.1. Top management must be enthusiastic and Top management must be enthusiastic and committed to the budget process.committed to the budget process.
2.2. Top management must not use the budget to Top management must not use the budget to pressure employees or blame them when pressure employees or blame them when something goes wrong.something goes wrong.
3.3. Highly achievable budget targets are usually Highly achievable budget targets are usually preferred when managers are rewarded based preferred when managers are rewarded based on meeting budget targets.on meeting budget targets.
The success of budgeting depends upon three The success of budgeting depends upon three important factors:important factors:
1.1. Top management must be enthusiastic and Top management must be enthusiastic and committed to the budget process.committed to the budget process.
2.2. Top management must not use the budget to Top management must not use the budget to pressure employees or blame them when pressure employees or blame them when something goes wrong.something goes wrong.
3.3. Highly achievable budget targets are usually Highly achievable budget targets are usually preferred when managers are rewarded based preferred when managers are rewarded based on meeting budget targets.on meeting budget targets.
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The Master Budget: An Overview
ProductionBudget
ProductionBudget
Selling andAdministrative
Budget
Selling andAdministrative
Budget
DirectMaterialsBudget
DirectMaterialsBudget
ManufacturingOverhead
Budget
ManufacturingOverhead
Budget
DirectLabor
Budget
DirectLabor
Budget
CashBudgetCash
Budget
SalesBudgetSales
Budget
Budgeted Financial StatementsBudgeted Financial StatementsBudgeted Financial StatementsBudgeted Financial Statements
EndingFinished GoodsBudget
EndingFinished GoodsBudget
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Budgeting Example
Royal Company is preparing budgets for the Royal Company is preparing budgets for the quarter ending June 30.quarter ending June 30.
Budgeted sales for the next five months are:Budgeted sales for the next five months are: April April 20,000 units20,000 units May May 50,000 units50,000 units June June 30,000 units30,000 units July July 25,000 units25,000 units August August 15,000 units.15,000 units.
The selling price is $10 per unit.The selling price is $10 per unit.
Royal Company is preparing budgets for the Royal Company is preparing budgets for the quarter ending June 30.quarter ending June 30.
Budgeted sales for the next five months are:Budgeted sales for the next five months are: April April 20,000 units20,000 units May May 50,000 units50,000 units June June 30,000 units30,000 units July July 25,000 units25,000 units August August 15,000 units.15,000 units.
The selling price is $10 per unit.The selling price is $10 per unit.
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The Sales Budget
The individual months of April, May, and June are summed to obtain the total projected sales in units
and dollars for the quarter ended June 30th
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Expected Cash Collections
• All sales are on account.All sales are on account.• Royal’s collection pattern is:Royal’s collection pattern is:
70% collected in the month of sale,70% collected in the month of sale, 25% collected in the month following sale,25% collected in the month following sale, 5% uncollectible.5% uncollectible.
• The March 31 accounts receivable balance of The March 31 accounts receivable balance of $30,000 will be collected in full.$30,000 will be collected in full.
• All sales are on account.All sales are on account.• Royal’s collection pattern is:Royal’s collection pattern is:
70% collected in the month of sale,70% collected in the month of sale, 25% collected in the month following sale,25% collected in the month following sale, 5% uncollectible.5% uncollectible.
• The March 31 accounts receivable balance of The March 31 accounts receivable balance of $30,000 will be collected in full.$30,000 will be collected in full.
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Expected Cash Collections
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The Production Budget
ProductionProductionBudgetBudget
Sales Sales BudgetBudget
andandExpectedExpected
CashCashCollectionsCollections
Complete
d
Production must be adequate to meet budgetedProduction must be adequate to meet budgetedsales and provide for sufficient ending inventory.sales and provide for sufficient ending inventory.
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The Production Budget
• The management at Royal Company wants The management at Royal Company wants ending inventory to be equal to ending inventory to be equal to 20%20% of the of the following month’s budgeted sales in units.following month’s budgeted sales in units.
• On March 31, 4,000 units were on hand.On March 31, 4,000 units were on hand.
Let’s prepare the production budget.Let’s prepare the production budget.
• The management at Royal Company wants The management at Royal Company wants ending inventory to be equal to ending inventory to be equal to 20%20% of the of the following month’s budgeted sales in units.following month’s budgeted sales in units.
• On March 31, 4,000 units were on hand.On March 31, 4,000 units were on hand.
Let’s prepare the production budget.Let’s prepare the production budget.
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The Production Budget
Assumed ending inventory.Assumed ending inventory.Assumed ending inventory.Assumed ending inventory.
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The Direct Materials Budget
• At Royal Company, At Royal Company, five poundsfive pounds of material of material are required per unit of product.are required per unit of product.
• Management wants materials on hand at Management wants materials on hand at the end of each month equal to the end of each month equal to 10%10% of the of the following month’s production.following month’s production.
• On March 31, 13,000 pounds of material On March 31, 13,000 pounds of material are on hand. Material cost is are on hand. Material cost is $0.40$0.40 per per pound.pound. Let’s prepare the direct materials budget.Let’s prepare the direct materials budget.
• At Royal Company, At Royal Company, five poundsfive pounds of material of material are required per unit of product.are required per unit of product.
• Management wants materials on hand at Management wants materials on hand at the end of each month equal to the end of each month equal to 10%10% of the of the following month’s production.following month’s production.
• On March 31, 13,000 pounds of material On March 31, 13,000 pounds of material are on hand. Material cost is are on hand. Material cost is $0.40$0.40 per per pound.pound. Let’s prepare the direct materials budget.Let’s prepare the direct materials budget.
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The Direct Materials Budget
Assumed ending inventoryAssumed ending inventoryAssumed ending inventoryAssumed ending inventory
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Expected Cash Disbursement for Materials
• Royal pays Royal pays $0.40 per pound$0.40 per pound for its materials. for its materials.
• One-half One-half of a month’s purchases is paid for in of a month’s purchases is paid for in the month of purchase; the other half is paid the month of purchase; the other half is paid in the following month.in the following month.
• The March 31 accounts payable balance is The March 31 accounts payable balance is $12,000.$12,000.
Let’s calculate expected cash disbursements.Let’s calculate expected cash disbursements.
• Royal pays Royal pays $0.40 per pound$0.40 per pound for its materials. for its materials.
• One-half One-half of a month’s purchases is paid for in of a month’s purchases is paid for in the month of purchase; the other half is paid the month of purchase; the other half is paid in the following month.in the following month.
• The March 31 accounts payable balance is The March 31 accounts payable balance is $12,000.$12,000.
Let’s calculate expected cash disbursements.Let’s calculate expected cash disbursements.
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Expected Cash Disbursement for Materials
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The Direct Labor Budget
• At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor.
• The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week.
• In exchange for the “no layoff” policy, workers agree to a wage rate of $10 per hour regardless of the hours worked (No overtime pay).
• For the next three months, the direct labor workforce will be paid for a minimum of 1,500 hours per month.
Let’s prepare the direct labor budget.Let’s prepare the direct labor budget.
• At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor.
• The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week.
• In exchange for the “no layoff” policy, workers agree to a wage rate of $10 per hour regardless of the hours worked (No overtime pay).
• For the next three months, the direct labor workforce will be paid for a minimum of 1,500 hours per month.
Let’s prepare the direct labor budget.Let’s prepare the direct labor budget.
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The Direct Labor Budget
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Manufacturing Overhead Budget
• At Royal manufacturing overhead is applied to units At Royal manufacturing overhead is applied to units of product on the basis of direct labor hours.of product on the basis of direct labor hours.
• The variable manufacturing overhead rate is $20 per The variable manufacturing overhead rate is $20 per direct labor hour.direct labor hour.
• Fixed manufacturing overhead is $50,000 per month Fixed manufacturing overhead is $50,000 per month and includes $20,000 of noncash costs (primarily and includes $20,000 of noncash costs (primarily depreciation of plant assets).depreciation of plant assets).
Let’s prepare the manufacturing overhead budget.Let’s prepare the manufacturing overhead budget.
• At Royal manufacturing overhead is applied to units At Royal manufacturing overhead is applied to units of product on the basis of direct labor hours.of product on the basis of direct labor hours.
• The variable manufacturing overhead rate is $20 per The variable manufacturing overhead rate is $20 per direct labor hour.direct labor hour.
• Fixed manufacturing overhead is $50,000 per month Fixed manufacturing overhead is $50,000 per month and includes $20,000 of noncash costs (primarily and includes $20,000 of noncash costs (primarily depreciation of plant assets).depreciation of plant assets).
Let’s prepare the manufacturing overhead budget.Let’s prepare the manufacturing overhead budget.
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Manufacturing Overhead Budget
Total mfg. OH for quarter $251,000Total labor hours required 5,050
= $49.70 per hour*
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Manufacturing Overhead Budget
Depreciation is a noncash charge.Depreciation is a noncash charge.Depreciation is a noncash charge.Depreciation is a noncash charge.
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Production costs per unit Quantity Cost Total Direct materials 5.00 lbs. 0.40$ 2.00$ Direct labor 0.05 hrs. 10.00$ 0.50 Manufacturing overhead 0.05 hrs. 49.70$ 2.49
4.99$
Budgeted finished goods inventory Ending inventory in units 5,000 Unit product cost 4.99$ Ending finished goods inventory 24,950$
Ending Finished Goods Inventory Budget
Production BudgetProduction BudgetProduction BudgetProduction Budget
Total mfg. OH for quarter $251,000Total labor hours required 5,050
= $49.70 per hour*
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Selling and Administrative Expense Budget
• At Royal, the selling and administrative expenses budget is At Royal, the selling and administrative expenses budget is divided into variable and fixed components.divided into variable and fixed components.
• The variable selling and administrative expenses are $0.50 The variable selling and administrative expenses are $0.50 per unit sold.per unit sold.
• Fixed selling and administrative expenses are $70,000 per Fixed selling and administrative expenses are $70,000 per month.month.
• The fixed selling and administrative expenses include The fixed selling and administrative expenses include $10,000 in costs – primarily depreciation – that are not cash $10,000 in costs – primarily depreciation – that are not cash outflows of the current monthoutflows of the current month..
Let’s prepare the company’s selling and administrative Let’s prepare the company’s selling and administrative expense budget.expense budget.
• At Royal, the selling and administrative expenses budget is At Royal, the selling and administrative expenses budget is divided into variable and fixed components.divided into variable and fixed components.
• The variable selling and administrative expenses are $0.50 The variable selling and administrative expenses are $0.50 per unit sold.per unit sold.
• Fixed selling and administrative expenses are $70,000 per Fixed selling and administrative expenses are $70,000 per month.month.
• The fixed selling and administrative expenses include The fixed selling and administrative expenses include $10,000 in costs – primarily depreciation – that are not cash $10,000 in costs – primarily depreciation – that are not cash outflows of the current monthoutflows of the current month..
Let’s prepare the company’s selling and administrative Let’s prepare the company’s selling and administrative expense budget.expense budget.
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Selling and Administrative Expense Budget
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Format of the Cash Budget
The cash budget is divided into The cash budget is divided into fourfour sections: sections:
1.1. Cash receipts listing all cash inflows excluding Cash receipts listing all cash inflows excluding borrowingborrowing
2.2. Cash disbursements listing all payments Cash disbursements listing all payments excluding repayments of principal and interestexcluding repayments of principal and interest
3.3. Cash excess or deficiencyCash excess or deficiency
4.4. The financing section listing all borrowings, The financing section listing all borrowings, repayments and interestrepayments and interest
The cash budget is divided into The cash budget is divided into fourfour sections: sections:
1.1. Cash receipts listing all cash inflows excluding Cash receipts listing all cash inflows excluding borrowingborrowing
2.2. Cash disbursements listing all payments Cash disbursements listing all payments excluding repayments of principal and interestexcluding repayments of principal and interest
3.3. Cash excess or deficiencyCash excess or deficiency
4.4. The financing section listing all borrowings, The financing section listing all borrowings, repayments and interestrepayments and interest
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The Cash Budget
Royal:Royal:Maintains a 16% open line of credit for $75,000Maintains a 16% open line of credit for $75,000
Maintains a minimum cash balance of $30,000Maintains a minimum cash balance of $30,000
Borrows on the first day of the month and repays Borrows on the first day of the month and repays loans on the last day of the monthloans on the last day of the month
Pays a cash dividend of $49,000 in AprilPays a cash dividend of $49,000 in April
Purchases $143,700 of equipment in May and Purchases $143,700 of equipment in May and $48,300 in June paid in cash$48,300 in June paid in cash
Has an April 1 cash balance of $40,000Has an April 1 cash balance of $40,000
Royal:Royal:Maintains a 16% open line of credit for $75,000Maintains a 16% open line of credit for $75,000
Maintains a minimum cash balance of $30,000Maintains a minimum cash balance of $30,000
Borrows on the first day of the month and repays Borrows on the first day of the month and repays loans on the last day of the monthloans on the last day of the month
Pays a cash dividend of $49,000 in AprilPays a cash dividend of $49,000 in April
Purchases $143,700 of equipment in May and Purchases $143,700 of equipment in May and $48,300 in June paid in cash$48,300 in June paid in cash
Has an April 1 cash balance of $40,000Has an April 1 cash balance of $40,000
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The Cash Budget
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The Budgeted Income Statement
Cash Budget
BudgetedIncome
Statement
Complete
d
After we complete the cash budget, After we complete the cash budget, we can prepare the budgeted income we can prepare the budgeted income
statement for Royal.statement for Royal.
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The Budgeted Income Statement
Royal CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000 Selling and administrative expenses 260,000 Operating income 241,000 Interest expense 2,000 Net income 239,000$
Sales BudgetSales BudgetSales BudgetSales Budget
Ending FinishedEnding FinishedGoods InventoryGoods InventoryEnding FinishedEnding FinishedGoods InventoryGoods Inventory
Selling and Selling and AdministrativeAdministrative
Expense BudgetExpense Budget
Selling and Selling and AdministrativeAdministrative
Expense BudgetExpense Budget
Cash BudgetCash BudgetCash BudgetCash Budget
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The Budgeted Balance Sheet
Royal reported the following account Royal reported the following account balances prior to preparing its budgeted balances prior to preparing its budgeted
financial statements:financial statements: Land - $50,000Land - $50,000 Common stock - $200,000Common stock - $200,000 Retained earnings - $146,150Retained earnings - $146,150 Equipment - $175,000Equipment - $175,000
Royal reported the following account Royal reported the following account balances prior to preparing its budgeted balances prior to preparing its budgeted
financial statements:financial statements: Land - $50,000Land - $50,000 Common stock - $200,000Common stock - $200,000 Retained earnings - $146,150Retained earnings - $146,150 Equipment - $175,000Equipment - $175,000
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Royal CompanyBudgeted Balance Sheet
June 30
Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets 147,550 Property and equipment Land 50,000 Equipment 367,000 Total property and equipment 417,000 Total assets 564,550$
Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
11,500 lbs.11,500 lbs.at $0.40/lb.at $0.40/lb.11,500 lbs.11,500 lbs.at $0.40/lb.at $0.40/lb.
5,000 units5,000 unitsat $4.99 eachat $4.99 each5,000 units5,000 units
at $4.99 eachat $4.99 each
50% of June50% of Junepurchases purchases of $56,800of $56,800
50% of June50% of Junepurchases purchases of $56,800of $56,800
25% of June25% of Junesales of sales of $300,000$300,000
25% of June25% of Junesales of sales of $300,000$300,000
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Royal CompanyBudgeted Balance Sheet
June 30
Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets 147,550 Property and equipment Land 50,000 Equipment 367,000 Total property and equipment 417,000 Total assets 564,550$
Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
Beginning balance 146,150$ Add: net income 239,000 Deduct: dividends (49,000) Ending balance 336,150$
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